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Cash Flow Expressed as Asset-Based Borrowing Availability

Posted on June 25th, 2017

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

In this article from Entrepreneur Magazine, “How Much Cash Do You Need for Your Business’s Safety Net?,” the author discusses the importance of maintaining sufficient liquidity in your business, or in other words, a cash reserve.

Then in another article from Entrepreneur Magazine, “The Ins and Outs of Cash Flow Statements,” the author explains the basics of what goes into creating a cash flow statement, including a link to this sample the author created in a spreadsheet: Sample – Traditional Cash Flow Statement.  Notice the bottom line of her sample is the ending “cash balance.”

But, what if your company is growing fast, and maintaining a sufficient cash reserve simply isn’t feasible. What then? Another way of looking at cash flow when you’re in a growth mode is in terms of borrowing availability against the company’s accounts receivable and inventory.  The difference here is that rather than forecasting a cash balance, you are now forecasting a cash requirement, and the ability to fund it externally through an outside lender, using the company’s accounts receivable and inventory as collateral.

Here’s what it looks like:

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Monthly Cash Flow Statement: The top section of this page is merely another cash flow format often used by banks to estimate a company’s ability to repay debt from cash flow.  It first converts accrual financial statements to a cash basis by calculating the changes in accounts receivable, inventory, accounts payable, and other miscellaneous balance sheet accounts to arrive at “Cash Available for Debt Service.”

Then, the general theory is, if “Cash Flow After Debt Service” is positive, the company is bankable.  If not, the company is growing too fast, or accounts receivable and/or inventory turnover is too slow, or maybe the company is losing money. In this sample, on average, a negative $113,488 (see report) is forecast for the year.  So, either an improvement in profitability or cash management is needed, or, some other type of non-bank lender or an equity infusion is more appropriate.

The next lines then reflect the “Financing and Investing Activities” (described in the “The Ins and Outs of Cash Flow Statements” article above).

Asset-Based Credit Facility – Borrowing Availability: Note in the Cash Flow Statement above the forecast ending cash balance of $10,000 through the end of the year.  This is just an assumed minimum balance the company desires to maintain in its bank account.

The next section then creates a whole different method of defining “Cash Reserves.” Instead of a cash balance, the above negative cash flow, or the “Change in Cash” after all operating, and long-term financing and investing activity, drives a funding requirement that is assumed to be funded under the company’s line of credit. The amount the company can actually borrow is then restricted to the percentage advance rate against receivables and inventory imposed by its lender, and whatever the lender considers to be “eligible” collateral, such as accounts receivable less than 60 or 90 days old, with a maximum advance on certain customers, inventory, and ultimately on the line of credit itself (i.e., the note amount).

In the above sample, the amount of borrowing availability is projected to be more than adequate to support the company’s cash requirements through the end of the projected period.  However, if circumstances change in the wrong direction, and certain major assumptions are altered, an “over-advance” may occur in the forecast.  If so, it’s an indication that either corrective action is needed internally, or alternative financing options must be explored to augment the company’s line of credit.  These “what-if”scenarios will be further demonstrated in future articles.                               

Related Articles:

Analyzing the Components of Cash Flow

The Effect of Sales Growth on Cash Flow

The Relationship Between Turnover Ratios and Cash Flow

Larry’s Funding Strategies, Inc.

Larry’s Debt Repayment Strategies, Inc.


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